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Understanding how to avoid punitive 60% tax rates

By RJP LLP on 29 April 2021

Did you know that without careful tax planning, many people in the UK - and not the ultra-wealthy - will be paying a top tax rate of 60% on some of their income or assets?

Are you paying income tax at 60%

Currently, the headline highest rate of income tax is 45%, but because of tapering rules, it can reach 60% due to the gradual withdrawal of the personal allowance. This affects people with an income over £100,000 but less than £125,140. It occurs because these taxpayers have their tax-free personal allowance reduced by £1 for every £2 earned within this income band. The effect of this is that the £25,140 income between this band is taxed at 60%. Earnings above the £125,140 level but less than £150,000 are then taxed at 40% and the rate rises up to 45% for income above £150,000. It is a very confusing and over complicated set of rules.

There are ways to mitigate the effect of the 60% tax rate, for instance by increasing your pension contributions or by gifting from gross income to reduce your taxable income to  £100,000.

Will your estate face a 60% IHT rate?

Inheritance tax (IHT) is typically charged at 40% on estates that are more valuable than the nil rate band allowance of £325,000. Married couples and those in civil partnerships are entitled to combine their allowances, generating a £650,000 tax free band. Furthermore, if you are gifting children or grandchildren your primary residence, the threshold increases by £175,000 per person. This is known as the main residence nil-rate band, which in these circumstances, increases the total IHT allowance for a couple to £1m.

However, for estates with a net value of £2m the IHT rate far exceeds the 40% rate. This is because the nil rate band tapers away by £1 for every £2 by which the value  exceeds the £2m estate threshold, up to a value of £2.7m. It creates an effective 60% rate for this £700,000 band of the estate’s value and represents a £140,000 increase in the tax otherwise payable. It may be possible to mitigate this higher rate by making lifetime gifts to children and grandchildren and making charitable donations.

If you would like forward tax planning advice to mitigate these higher tax rates, please email us at partners@rjp.co.uk.

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